On today’s show we are talking about how to determine the structure of an investment offering.
We often hear about the so-called 2 & 20 formula that is popular among fund managers. When we say 2 & 20, that refers to a 2% asset management fee measured on the value of the fund, plus a 20% carried interest in the ownership of the fund. For many funds, that 2% fee is an annual fee. Over a 10 year life of a fund, that fee can amount to 20% of the original investment. That means the investors get 80% of the profits in the fund. Naturally, for that formula to work, the fund needs to generate enough returns for the investors to more than make up for the fees being charged by the fund manager. In publicly listed funds that are considered liquid, fund managers sometimes charge a 7% up front fee. Investors can sell at any time after the first year, but clearly they are going to pay a penalty for selling early.
That’s in the world of mutual funds. The fund managers are merely placing money in operating businesses. They perform their due diligence on the investments and they sprinkle their funds across a number of investments. The fund manager doesn’t do any of the heavy lifting associated with running the active businesses.
In the world of real estate investments, sometimes that can be a fund which will invest in several projects.
More often, the investment is in a single asset. It might be an apartment complex or a storage facility or a land development, or an industrial building. This requires active management of the businesses. I sometimes see the same 2 & 20 being applied to single asset investments.
But in truth there is no real industry standard. Whatever structure you can imagine and investors will embrace can work, of course as long as it is compliant with securities regulations. On today’s show we are going to talk through the thought process that goes into determining how to design an investment offering.